Iran's Economy in the Shadow of Regional Upheaval

by SUZANNE MALONEY

Tehran's surprising ability to take politically risky, economically rational decisions at a time of intense international pressure over its nuclear program confounds external observers.

[ analysis ] Iran's stability is once again in question, as historic protests sweep the Middle East and revive the flagging fortunes of its own opposition movement. Expectations of the Islamic Republic's inevitable demise are further fueled by the revolutionary state's own vulnerabilities.

Political elites are constantly at war with one another. Much of the clerical estate is alienated from theocratic rule. The merchant community has fought both the encroachments of the state and tax obligations. And youth -- who represent more than two-thirds of the population -- are simply fed up with the lack of opportunities and the stultifying social and cultural restrictions. Since the disputed June 2009 presidential election, a new homegrown opposition movement has emerged, led by political revolutionary stalwarts and propelled by millions of ordinary Iranians who took to the streets for six months.

Iran's economic predicament has particularly provoked popular frustration with the post-revolutionary regime. Iran boasts the world's second largest reserves of oil and gas. But revolution, war, sanctions, and internal philosophical differences over economic policy have dramatically eroded per capita income.

Iran today suffers from a wide range of economic problems. It has failed to create enough jobs, particularly for new entrants to the labor market. Inflation has reached epic rates in recent years. It has a chronic overreliance on petroleum revenues. Sanctions have raised the cost, time and inconvenience of almost all international transactions. It has underdeveloped capital and financial markets. And growth rates, which tanked as a result of the global economic slowdown, have been exacerbated by maladroit government interventions.

Yet just as the regional upheaval threatens to infect Iran, the Islamic Republic may be on track to alleviate one of the most significant dimensions of its economic Achilles' heel. In late 2010, the government embarked on sweeping economic reforms that eliminate state subsidies on a range of essential consumer goods -- including bread and gasoline -- and provide modest cash payments to every Iranian household.

The subsidy reforms are still in the first of many phases. Yet its surprisingly smooth launch may help insulate Iran from the sort of economic grievances that helped spark the Tunisian uprising in December and have contributed to the broader phenomenon of revolutionary mobilization that has spread across the region. Oil revenues have also had a major boost since the spike in oil prices as a result of unrest in Libya and Bahrain. So Iran's economic prospects may now be decreasing even as the impact of multilateral sanctions over its nuclear program intensifies.

Technocrats across Iran's political spectrum fully understood that the state's spending on subsidies -- estimated at about $100 billion per year -- was seriously inefficient and created damaging distortions within the economy. Among other problems, Iran's domestic energy consumption exceeded almost any country on the planet. The government estimated about 30 percent of subsidized bread was either thrown away or smuggled out of the country.

Several Iranian leaders supported subsidy reform. But neither reformists nor conservatives were eager to push forward a program that would entail price hikes on key commodities. By contrast, President Mahmoud Ahmadinejad seemed to welcome the opportunity for a major policy initiative, and began pressing for a dramatic reform plan in mid-2008.

After a prolonged, acrimonious battle with the Iranian parliament, the reforms were formally launched after a long delay in December. They included quadrupling the price of gasoline as well as a range of other goods. To offset the shock, the government distributed approximately $77 to each Iranian household several months earlier, in bank accounts that were locked until the price increases were implemented.

Ahmadinejad's program is hardly an example of perfect policymaking. The opaque implementation, particularly sparse information about new prices until the last moment, has fueled uncertainties corrosive to healthy economic planning or growth. Legitimate concerns about inflation remain, particularly with the next round of payments due to overlap with Iran's annual New Year's bonuses (in March) and shopping season. It remains unclear whether the poor, who were disproportionately disadvantaged by the price subsidies, will see meaningful improvements in their standard of living, particularly as consumer products become more expensive.

The program also entails a profoundly interventionist role for the government, perpetuating a longstanding flaw in the Iranian economy. The state (and perhaps most important for domestic politics, the Ahmadinejad presidency) remains firmly in control of the economy. Government decisions -- about how to invest budget savings and which industries or firms should get financial support to offset price rises -- will shape the future of the Iranian economy.

The result is unlikely to favor a truly liberalized market economy, given Iran's track record and Ahmadinejad's heavily politicized policies. The regime has also used the program as a pretext excuse to intensify repression against its internal critics, repeatedly warning that public protests over price increases would be considered treason and dealt with harshly.

Iranians reacted with resignation when price increases went into effect in January, whether cowed by threats or convinced by the long debate between Ahmadinejad and parliament over the reforms' scope and timing. Implementation has reportedly faced a wide variety of small-scale problems, particularly as cash payments were based on voluntary household surveys.

By and large, however, the reforms appear to be having the intended effect. Consumption of electricity and gasoline has already dropped substantially. Use of Tehran's anemic public transportation system has boomed. There are corollary benefits. The banking sector rushed to attract new clients. And initial payouts helped stimulate investment in small-scale entrepreneurship, according to anecdotal reports.

Successful implementation of reforms would represent a policy corrective as monumental as any the Islamic Republic has ever attempted. It would be similar to Iran's reversal in the 1980s on family planning policies, which helped turn around skyrocketing (and economically unsustainable) birth rates.

The new program has the potential to spur a virtuous cycle of economic liberalization. It could help strengthen the banking sector, increase private savings and investment, reduce smuggling and other black market activities, and rationalize deep distortions in the manufacturing and other sectors. Most powerfully, the reforms could create a sense of individual ownership in the economy by giving Iranians greater control over the spending of the national wealth.

Politically, the program may also help preserve the regime's hold on power by insulating it from the coercive force of comprehensive international sanctions and assuaging grievances of the poorest strata of Iranians. Although recent regional unrest has been portrayed as largely political, economic grievances helped initiate the movement. The self-immolation by a Tunisian street vendor sparked the upheavals in December.

The sense of disempowerment and frustration over the lack of economic opportunities that is prevalent throughout the Middle East helped fuel a powerful force for social mobilization. If Tehran can successfully navigate those pressures, the regime may succeed where several Arab states have failed, thanks to its two-track strategy of repression and economic inducements to stave off popular dissatisfaction.

Beyond the immediate stability of the Iranian regime, the reform program's early achievements challenge assumptions about the government's functionality -- or lack thereof. The regime is brutal and nondemocratic, and that many of its policies both at home and abroad are deeply problematic.

But outside observers often indulge in overgeneralization and oversimplification about Tehran. Most media and policy analyses of Iran's economy rely heavily on a few popular adjectives: mismanaged, disastrous, bloated, failing. These descriptors are broadly accurate, and yet they do not capture the reality or the subtleties of economic policymaking, even as the role of technocrats has been largely devalued under Ahmadinejad.

The subsidy reform program represents a serious and rational response to Iran's economic predicament which requires a considerable degree of bureaucratic competence over a protracted time period. Millions of new bank accounts were established. Smart card technology was adopted for the country's gas stations. And a sustained public education campaign was carried out. Implementation has required intensive coordination among a variety of government ministries and private sector organizations, as well as ongoing wrangling with a skeptical parliament.

Despite its manifest flaws, the program receives quiet plaudits from external economists and is being watched closely by other governments struggling to divest themselves of unsustainable benefits.

The decision to embark on such a dramatic, and ultimately risky, reform also offers new insight into Iran's current leadership, particularly Ahmadinejad, who has championed the program, and Iran's supreme leader Ayatollah Ali Khamenei, who is the ultimate authority in Iran. Khamenei has never previously demonstrated a subtle appreciation for economic policy. And many across the spectrum of permissible political discourse (including reformers who form the core of the Green Movement) were far more hesitant about embracing such a far-reaching undertaking, largely out of concern about the social and political upheaval that dramatic price rises might entail.

In the external media, the subsidy reform program is typically depicted as a response to mounting international sanctions. That is not strictly accurate. Its embrace dates to the time when Washington's push for international sanctions had largely run aground. This coincided with the inception of the global economic slowdown and the collapse of oil prices after a five-year boom. But Ahmadinejad and other senior political figures consistently exulted in the worldwide recession; they gave little indication that they appreciated the eventual implications for Iran's economy. But the economic crisis, as well as the looming constraint of international economic pressure, surely played into the two-and-a-half year debate within Iran's parliament over whether, how, and when to implement the program.

Recognition of the potential political benefits may be what ultimately spurred Iran to enact reforms. Ahmadinejad can now claim that he has made good on his initial campaign promises to put the nation's oil money on the sofreh (tablecloth) of the people. And Iran's government may be less vulnerable, as long as its citizens are counting on a bimonthly cash payout.

Tehran's ability to take politically risky, economically rational decisions at a time of intense international pressure over its nuclear program is surprising. Its capacity to implement a complex, nation-wide program without massive social dislocations (yet) is a timely reminder that external observers often underestimate the Islamic Republic's capacity for surprise, self-preservation and sharp appreciation for the costs and benefits of its policy options.

Suzanne Maloney is a senior fellow at the Saban Center for Middle East Policy at the Brookings Institution. She is the author of "Iran's Long Reach" (2008) and a forthcoming book on Iran's political economy since the Revolution. This article is presented by Tehran Bureau, the U.S. Institute of Peace, and the Woodrow Wilson International Center for Scholars as part of the Iran project at iranprimer.usip.org.

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